The decision to add hospital capacity has been explained in terms of sociology, medicine, strategy, physician power, oligopoly theory, and a variety of other perspectives. Financial factors of efficiency and return- on-investment have not been paramount. However, after October, 1991, when capital costs will no longer be directly reimbursed, this should change. The reaction of hospital decision-makers to this is an important research issue. So far capital costs have not responded to Medicare Prospective Payment System [PPS] to the degree shown by operating costs. Yet the plan to include payment for interest and depreciation in a flat case-level DRG rate implicitly assumes that capacity decisions will become more responsive in the future. This may not be warranted. This project will provide empirical estimates of the impact on net capital expansion and contraction of financial results, need & efficiency, institutional characteristics, market conditions, and payment parameters. Regressions will be run on the universe of all U.S. hospitals filing a Medicare Cost Report [MCR] over a two year base period (1988-89), a two year anticipation period before the actual shape of Medicare capital payment was known (1990-1991), and a three year initial implementation period (1992-1994). Amplifying the regressions will be a series of case studies and extensive questionnaires and interviews on the capital decision process taken from a stratified random sample of expanding and contracting hospitals. These will be used to expand the basic empirical work to a richer, more useful behavioral model. The key study questions concern [1] the decision process discernable in the 1988-89 base period; [2] the degree of change in investment behavior under fixed capital payment; [3] how hospital specific efficiency, cost, intensity, and quality relate to past and present capital expenditures; and [4] how access to the capital market due to ownership, tax status and financial strength, restrict or encourage capacity expansion, consolidation, or contraction.